For the 2002 tax year, our beloved government has slipped in a little surprise for those of you who contribute to IRA's (any kind).

If your employer has you covered under any kind of retirement plan, you may not be able to contribute as before (see the tables on page 124-125 of Pub 17 for 2002).

If this new rule applies to you, you may end up paying a 6% excise tax on excess contributions. Notice that this applies to almost all government employees (including military, weather they plan to stay in 20 years or not!)

Everybody together, say, "Thank you, Uncle Sam!"

The good news:

Taxpayers who contribute to almost any kind of retirement plan can now double-dip! In addition to having either tax-free contributions or tax-free growth, you can take an additional credit ("retirement savings contributions credit") to reduce your tax liability.

The credit is equal to a percentage of what you contributed during the year (up to $2000), and is applied against your taxes, not your income. This can be a pretty substantial incentive to get into a savings program.

(See pages 260-261 in Pub 17 for 2002.)

mahal: Have you done the calculations to arrive at your conclusion? If something looks too good to be true, it probably is. Actually it sounds as though one should try to claim as many dependents as possible so that one has a sufficient tax liability in the first place against which to apply the supposedly compensating percentage tax credit. The whole thing sounds like an experiment. Want to bet? With the sorry state of indebtedness in which many municipalities find themselves, it also looks as though this is a political invention to get government workers to invest more in their retirement plans to help the municipalities in some way. What is the story on this political invention for the state/city taxes?

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Originally posted by tsaeb:
mahal: Have you done the calculations to arrive at your conclusion?

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Not sure which one you're talking about, the bad news or the good news, but there were no calculations involved.

That bad news is that IRA's are phased out at certain levels of income, and if you're not ready for it, you could contribute up to your $3000 limit for the year and find that you have to pay a small fine for depositing too much! (See the tables that I referenced.) If you try to withdraw the contributions to correct the problem, you'll pay a 10% early distribution penalty (unless you're over 59 1/2).

The good news is that there are now two places on your 1040 form to claim IRA contributions, line 25 for the IRA deduction (this one adjusts your income down before tax), and line 50 on the back (this one adjusts your tax down as a credit). You're eligible to take the credit if you've contributed to an IRA, a 401K, a SIMPLE, a TSP or any other qualified retirement plan out of your own pocket.

Becaues I'm married filing joint, I was able to get back 50% of what I contributed to my TSP during 2002. (You can't include your employer's contribution, and you have to reduce the credit by any money you took out of the account during the year.)

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If something looks too good to be true, it probably is.

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Usually, this is probably true. Nevertheless that word I quoted above, "double-dip" is a direct quote from the IRS guy training us this week to handle the new tax laws. There has never been a credit that you can take twice; this is the first.

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What is the story on this political invention for the state/city taxes?

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We only train in federal taxes. City and state income taxes vary a great deal, and the benefits vary as well. (Actually, I think there are very few cities that have an income tax.)

mahal: Although you did not address my idea of a political invention of some sought, I am now thinking that necessity is the mother of invention, which means that I am wondering in how bad shape our economy and government on all levels are in.

I'm wondering if these new tax laws are just a ploy to get our beloved GW reelected.

Currently, GW's opponents are saying that his new tax laws are only going to benefit the rich (those with investments). This couldn't be farther from the truth!

Did you hear about his proposal to raise the Child Tax Credit from $600 to $1000? For poor families with kids, not only will this raise the "zero bracket" by more than $1000 per kid, the government will actually be giving away more free money to poor families in the form of the "additional child tax credit". Poor families will see their refunds raised each year by several hundred dollars.

The new IRA laws are similar. (See my post under that topic, "unexpected benefit".)